Liquidity tightened on 3G outflows; RBI introduced ad-hoc liquidity measures

Highlights:

• Bonds take a break from a continuous 5 week rally; the benchmark bond 6.35% 2020 yield moved to 7.55%, up by 18 bps
• Domestic bond market mirrored US Govt. Bonds; US Treasury bonds’ yields rallied on account of poor consumer spending data
• Liquidity took a major hit; the 3G payments coupled with advance tax outflows put a strain on liquidity
• The RBI announced two liquidity easing measures – additional liquidity support up to 0.5% of banks’ NDTL and 2nd LAF (SLAF) on daily basis
• Call rates and inter-bank rates are likely to go up this week


View & Recommendation:
• With yields easing, fund managers have started increasing the average maturity of income funds, thereby, increasing their ranks in terms of returns.
• Investors looking for investments for a shorter period (6 months - 1 year) should invest in Ultra Short Term Funds (erstwhile called as Liquid Plus Funds) while those looking for a longer investment horizon (1.5 - 3 years) should invest in Income Funds.
• Some of the recommended Income Funds are Birla Sun Life Dynamic Bond Fund, ICICI Prudential Income Fund and Kotak Bond Regular Plan.

Broader Perspectives:
Bond Front
Indian bond markets took a break from a 5-week rally mirroring the movements in US Treasury yields and also incorporating the domestic factors such as liquidity crisis. However, the cancellation of weekly auctions looks distant as the government has other payment commitments such as Cash Management Bills worth Rs. 20,000 Cr, Bond maturities worth Rs. 50,000 Cr in July, cut in Treasury Bills auction size limited to Rs. 22,000 Cr along with government funding to Oil Marketing Companies (OMCs) to the tune of Rs. 14,000 Cr.

Earlier, last week, the bonds rallied after an announcement of probable cancellation of bond auctions this week due to liquidity squeeze arising out of 3G outflows and advance tax payments. The 3G outflows alone is sucking liquidity to an extent of Rs. 67,719 Cr.

The 10-year Benchmark Bond 6.35 per cent 2020 yield shot to 7.55 per cent, up by 18 bps over its last week close. The other heavily traded bond 8.20 per cent 2022 saw yields rise by 17bps to 7.80 per cent on weak-on-weak basis. The average trading volume for G-Secs as reported in NDS-OM platform was Rs. 19,985 Cr. Last week, there were 4 trading days only as the banks were closed on Thrusday (May 27, 2010).


Bond Supply
The government auctioned bonds worth Rs. 12,000 Cr. The notified auction amount was Rs. 4,000 Cr, Rs. 5,000 Cr and Rs. 3,000 Cr for 7.38% G-Sec 2015, 7.80% G-Sec 2020 and 8.32% G-Sec 2032 respectively. The bid to cover ratio was highest (2.5 times) in 10-year benchmark paper, the highest traded paper. The cut-off came in at 7.41 per cent, 7.60 per cent and 8.25 per cent respectively. The government will buyback Cash Management Bills worth Rs. 20,000 Cr this week.


Liquidity Desk
The liquidity was tight last week on account of 3G auction payments by Telecom Companies. Moreover, the advance tax outflows as expected on June 15 have also started putting strain on Liquidity. To ease the pressure, the RBI announced special measures to provide liquidity in the system. The RBI allowed banks additional support under the liquidity adjustment facility. The Central Bank will conduct two rounds of LAF operations. It also permitted banks to avail support of up to 0.5 per cent of their Net Demand and Time Liabilities (NDTL), the steps which will provide an additional liquidity support of Rs. 20,000 Cr. Both the measures would be applicable till July 02, 2010

 Corporate Desk
Corporate bond yields hardened across the tenors. The AAA, 10-year paper hardened to 8.67% compared to 8.60% compared to last week. The 1-year bond traded at a yield of 6.65 per cent. This week, corporate bonds’ yields rose less than the government bond yields. The ten-year benchmark AAA spread shrank to 96bps, down by 14 bps. Corporate bond yields are likely to move higher on account of liquidity worries and interest rate spikes.